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January/February 2009 (http://www.bostonreview.net/current_issue)
Tools for a New Economy
Proposals for a financial regulatory system Robert Pollin
The collapse of the housing bubble and the speculative market for subprime mortgages
demonstrates, yet again, the simple point that financial markets need tight regulation.
Since September 2008 a series of massive bailouts by the U.S. Treasury and Federal
Reserve have prevented financial markets from experiencing a1929-style collapse. These
extreme measures, however, have not solved the broader problems at hand. As of this
writing, we are experiencing the most severe economic downturn since the 1930s.
American politicians—Democrats and Republicans alike—began deregulating the U.S.
financial system in the 1970s. Their premise was that regulations devised during the
1930s—specifically the Glass-Steagall system, which defined separate spheres for
commercial and investment banks—would hinder the effective workings of contemporary
financial markets. The 2001 Economic Report of the President, Bill Clinton’s last,
unequivocally dismissed Glass-Steagall: “Given the massive financial instability of the
1930s, narrowing the range of banks’ activities was arguably important for that day and
age. But those rules are not needed today.”
The chorus of politicians and economists who for a generation advocated financial
deregulation were right about one thing: the financial system has become infinitely more
complex since the 1930s. Something that had been as simple as a local Savings & Loan
making a home mortgage in their community—recall Jimmy Stewart in It’s a Wonderful
Life—is now part of a speculative global market. The old regulations had indeed become
outmoded, but it never followed that financial markets should operate unregulated.
The historical record makes this clear. In the classic text Manias, Panics and Crashes,
Charles Kindleberger called financial crises a “hardy perennial” within the context of
unregulated financial systems. He documented that, from 1725 onward, financial crises
have occurred throughout the Western capitalist economies at an average rate of about
one every eight and half years.
There is an awful lot about the current financial crisis that is familiar. In 2001 the the U.S.
stock market crashed after having been driven during the late 1990s to unprecedented
levels of speculative frenzy by the dot-com boom. A global financial crisis originated in
East Asia in 1997-98 and spread rapidly. The sure-thing investment then was securities
markets in developing countries. The U.S. hedge fund Long Term Capital
Management—its board of directors guided by two Nobel Prize–winning economists
specializing in finance—disintegrated in that crisis, requiring a $4 billion bailout from
other Wall Street firms to prevent a market meltdown.
The most severe crash of an overwrought financial market, the 1929 Wall Street crash,
produced an economic calamity, which led in turn to a collapse of the U.S. banking
system. Between 1929 and 1933, nearly 40 percent of the nation’s banks disappeared. In
their wake, Roosevelt’s New Deal government put in place an extensive system of
financial regulations, many of which persisted beyond the conclusion of the Great
Depression. The most important initiative was the 1933 Glass-Steagall Act, or, as it is
officially known, the Banking Act. Commercial banks were limited to the relatively
humdrum tasks of accepting deposits, managing checking accounts, and making business
loans. Commercial banks would also be monitored by the newly formed Federal Deposit
Insurance Corporation (FDIC), which provided government-sponsored deposit insurance
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for the banks in exchange for close government scrutiny of their activities. Investment
banks, by contrast, could freely invest their clients’ money on Wall Street and undertake
other high-risk activities, but they had to steer clear of the commercial banks.
Similar regulations were imposed on Savings & Loans (S&Ls) in 1932, and continued to
operate through the 1970s. In particular, under the old regulatory regime, mortgage loans
in the United States could be issued only by S&Ls and related institutions. The
government regulated the rates S&Ls could charge on mortgages, and the S&Ls were
prohibited from holding highly speculative assets in their portfolios.
But even during the New Deal years themselves, financial-market titans were already
fighting to eliminate or at least defang the regulations. Since the 1970s, they have almost
always gotten their way. This led cumulatively to the dismantling of Glass-Steagall. The
final nail in the coffin came in 1999 when President Clinton signed the Financial Services
Modernization Act. He did so with the strong support of then-Senator Phil Gramm, later a
top advisor to John McCain’s Presidential campaign; then-Federal Reserve Chair Alan
Greenspan; and top advisors Robert Rubin and Lawrence Summers, both of whom would
later counsel the Obama campaign and transition team.
While the current crisis resembles its predecessors in many ways, it also has some novel
characteristics. Its most prominent distinction is that it has resulted from activities that
were supposed to benefit working families. Banks created opportunities for families with
less-than-stellar credit records to obtain mortgages and buy their own homes. By bundling
thousands of mortgages into securities that were freely traded on global financial markets,
banks enabled subprime borrowers to purchase houses that would otherwise have been off
limits. This kind of financial engineering, operating on a global scale, could not have been
possible under the Glass-Steagall system.
We need a new regulatory framework that is capable of stabilizing markets and
channeling financial resources away from the speculative casino.
The idea behind bundling mortgages into marketable securities is that the local bank or
S&L that lends you money to buy a home does not hold onto your loan once you get your
money. Rather, it sells your loan to a big financial institution, such as the governmentsponsored Fannie Mae or Freddie Mac, which, in turn, bundles thousands of individual
mortgages into securities. Fannie or Freddie then sells these mortgage-backed securities to
banks, hedge funds, and other market players. With thousands of mortgages packaged into
one security, the dangers of lending to higher-risk borrowers are supposed to decline;
within a large portfolio of mortgages, the losses lenders incur from the small share of
delinquent borrowers are offset by the much larger proportion of borrowers in good
standing.
Market players became convinced that “securitizing” loans made subprime mortgage
lending a much safer bet. For a time, optimistic expectations became self-fulfilling. Money
rapidly flowed into the market. Housing prices rose, seemingly creating wealth out of thin
air for homeowners. Market bulls grew rich while bears seemed out-of-step. Loan officers
earned handsome commissions by bringing new customers to their banks. These officers
had large incentives to approve subprime mortgages—they did not have to return their
commissions years later when, for example, the loans, now held by a Swiss hedge fund,
went sour.
The logic here is deeply flawed. Market players believed that the riskiness of subprime
mortgages would diminish when pooled. In fact, the opposite turned out to be true. The
fortunes of most subprime borrowers rose and fell together with the housing market’s
boom and bust. In the bust, the problems borrowers faced in meeting monthly payments
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became pervasive, not limited to isolated cases. This is why major financial institutions
such as Citigroup, Merrill Lynch, and Bear Stearns, which were holding huge pools of
subprime mortgages, experienced unprecedented losses in 2007, setting off the collapse of
U.S. financial markets. Today’s crisis is thus the direct consequence of the generation-long
project of deregulating financial markets.
***
We need a new regulatory framework that is capable of both stabilizing markets and,
correspondingly, channeling financial resources toward productive and socially useful
investments and away from the speculative casino. What follows is a series of proposals to
guide the new framework. They offer a decisive break from the deregulatory agenda of
the past generation, yet they are all feasible within the existing set of political and
regulatory institutions. Enacting them would require insignificant increases in
administrative costs and low levels of public outlay. All of these proposals have been
debated seriously within mainstream political circles.
U.S. markets, of course, operate within a globally integrated setting, a reality that
complicates any regulatory scheme. These proposals are intended to apply to all financial
institutions under U.S. legal jurisdiction, whether they are called banks, holding
companies, hedge funds, or variations thereof.
My first proposal is the establishment of a small tax on all trading of financial assets.
Financial markets do provide an essential service by simplifying the conversion of
investments into money. But this benefit must be weighed against the fact that trading has
almost nothing to do with raising funds for investment. As of 2007, players in the market
traded roughly $300 worth of stocks and bonds for every dollar that nonfinancial
corporations raise for new investments in plant and equipment. This ratio is about three
times what it was only a decade ago, at the peak of the dot-com bubble.
A small tax on all financial-market transactions, comparable to a sales tax, would raise the
costs on short-term speculative trading while having negligible effect on people who trade
infrequently. It would thus discourage speculation and channel funds toward productive
investment. Securities-trading taxes are common throughout the world. Roughly forty
countries, including Japan, the United Kingdom, Germany, Italy, France, China, Brazil,
India, South Africa, and Chile employ or have recently employed such a tax.
In the aftermath of the 1987 crash, securities-trading taxes or similar measures were
endorsed by then-House Speaker Jim Wright, then-Senate Minority Leader Bob Dole, and
even the first President Bush. Variations on the idea have been introduced in Congress
regularly in subsequent years, but never passed into law. Two leading Clinton
administration economists, Nobel Laureate Joseph Stiglitz and Summers, argued
persuasively for such a tax in the late 1980s. Summers disavowed the idea soon after
joining the Clinton Treasury, becoming instead a major supporter of the deregulation
agenda of the Clinton years. What Summers might support now, as the head of National
Economic Council under President Obama, is an open question.
The technical features of a trading tax are simple. For stocks, the seller could be charged,
for example, 0.5 percent of the sale price (Jim Wright suggested this rate in 1987). For
bonds, the tax would be proportional to the bond’s duration, at a rate of 0.01 percent per
year. Thus, the tax on selling a thirty-year bond would be 0.3 percent, and a tax on a
fifty-year bond, 0.5 percent. The tax would be adjusted on a comparable basis for
derivative financial instruments, such as options, futures, and credit swaps. Brokers would
be responsible for collecting the tax from the sellers at the time of sale.
Since the IRS already imposes trade-reporting requirements, a securities trade tax would
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entail little additional administrative apparatus. Nor would it have a significant impact on
anyone who bought an asset and did not promptly resell it for a quick profit. For someone
who buys stock at $50/share and sells it ten years later at $100/share, the trading tax
would be $0.50 per share, on a $50 capital gain.
Conversely, a 0.5 percent tax would seriously reduce profit for short-term speculators. It
is not uncommon for speculators to buy a stock, hold it for a day or even hours, and then
resell it for a small gain. A $1 capital gain for a $99 share bought yesterday and sold today
$100 today nets a good return on a one-day investment. The trading tax would garner 50
cents—half the earnings from the trade.
One could use the tax on its own to cut financial speculation dramatically. That would
only entail raising the tax rate until the point where traders see little incentive to trade at
all. But the aim is not to shut off trading altogether; if that were the case, full
nationalization of the financial markets would probably be a more effective approach.
Even at a rate too low to dampen speculation, the securities-trading tax has another
benefit. It would provide a new source of government revenue at a time when it is badly
needed. Working with 2007 figures, I estimate that a 0.5 percent tax on stock trades, and
the sliding scale described above for bonds and derivatives, would raise approximately
$350 billion, if trading did not decline at all after the tax was imposed. Even if trading
declined by 50 percent as a result of the tax, the government would still raise $175 billion,
roughly equal to both the entire Iraq war budget for 2008 and the April 2008 fiscal
stimulus initiative. The securities trading tax, moreover, could be designed as a major
revenue source to fund any new regulatory apparatus for other government initiatives.
But a modest tax on securities trading is not enough, on its own, to discourage speculation
and channel credit to where it is most needed. A second proposal, if adopted, would
increase democratic accountability within the Federal Reserve System, which would in
turn raise accountability throughout the regulatory apparatus as well as in private markets.
Proposals for democratizing the Federal Reserve have long been advanced in mainstream
political circles through the efforts of Congressmen Wright Patman, Henry Reuss, and
Henry Gonzales, among others. These three men served, respectively, as Chair of the
House Banking Committee from 1963-75, 1976-82, and 1989-94.
Specifically, the Fed must be able to promote the channeling of credit to productive
purposes over speculation.
The best approach to democratization would begin with redistributing power downward to
the twelve district banks of the Federal Reserve System, then opening the presidencies of
these banks to direct elections. At present, the banks are highly undemocratic, and they
have no real power. I propose the reverse: accountable and empowered district banks.
When the Federal Reserve system was formed in 1913, the twelve district banks were
supposed to disperse the central bank’s authority broadly and respond to regional needs.
This remains a valuable idea, but it has never been seriously implemented. Bank
presidents are currently appointed by the banks’ boards of directors. These are
businesspeople, mostly commercial bankers, who are also appointed, not elected.
At the level of national policy-making, the district banks have influence only because five
of the twelve bank presidents sit, on a rotating basis, on the Federal Open Market
Committee, the body that votes on all monetary policy initiatives by the Fed. However,
under present arrangements, the Chair of the Fed, who is also the Chair of the Open
Market Committee, exercises predominant influence over the full Committee, usually
acting in consultation with the Treasury Secretary.
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The direct election of district bank presidents by residents of the relevant regions would
democratize the banks. And creating additional seats for them on the Open Market
Committee would increase their power. District bank presidents, once on the Committee
as elected representatives from their regions, could explicitly address the concerns of their
constituents.
A related proposal would build on an experiment from the 1930s when district banks
formed committees of bankers and businesspeople to discuss financial-market issues in a
non-market setting. This model could now be extended to include labor, consumer, and
community representatives.
Strengthening the Fed’s policy toolkit is a third crucial component of any plan to increase
democratic accountability. Specifically, the Fed must be able to promote the channeling of
credit to productive purposes over speculation. Without this tool, extending democracy
within the institution will be largely symbolic.
A system of “asset reserve requirements,” which would oblige financial institutions to
maintain cash reserve funds in proportion to the high-risk assets in their portfolios, would
encourage banks, hedge funds, and the rest to channel credit to high-priority and less-risky
areas. This idea has an extensive, if largely neglected, mainstream pedigree. MIT’s Lester
Thurow, for example, sketched the following arrangement in a 1972 paper written for a
conference at the Federal Reserve Bank of Boston:
If national goals called for investing 25 percent of national savings in housing
and other preferred sectors, each financial institution would have a 100
percent reserve requirement on that fraction of its assets. As long as it
invested 25 percent of its assets in housing, however, it would not have to
leave any reserves with the government. If it had invested 20 percent of its
assets in housing, five percent of its assets would have to be held with the
government in required reserves. If it invested nothing, 25 percent of its
assets would be held as reserves.
Other specific versions of asset reserve requirements were outlined in the 1970s by former
Federal Reserve Governors Andrew Brimmer and Sherman Maisel. Their proposals were,
more or less, in support of unsuccessful efforts by Senator William Proxmire and
Representative Reuss—then chairs of the Senate and House Banking Committees,
respectively—to advance bills establishing procedures for Federal Reserve–directed credit
allocation policies.
In fact, the equivalent of asset reserve requirements has long been established practice in
the United States. S&Ls, after all, originally had their loan portfolios restricted to
fixed-rate home mortgages. That could be described as a 100 percent asset reserve
requirement.
Policymakers should first—either within a democratized Federal Reserve or in a broader
dialogue—determine which sectors of the economy get preferential access to credit. In my
view, we should encourage domestic investments in which risks are relatively well
understood, and, correspondingly, discourage speculative investments where risks are
relatively opaque. Beyond that, we should give preference to job-creation, subsidizing the
growth of green investments and the fight against global warming, and affordable housing.
The financing of affordable housing, for example, would then be subsidized directly by
public-policy arrangements, and not, as in the last decade, as a byproduct of high-stakes
gambling.
With established goals, this policy gives significant social control over major finance and
investment activities, while allowing considerable decision-making freedom for both
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intermediaries and businesses. Intermediaries would still be responsible for establishing
the credit-worthiness of businesses and the viability of their projects. Businesses would
still be responsible for the design and implementation of their investments. Indeed,
business would still have freedom to pursue nonpreferred projects, and banks could still
finance them. Financing costs would just be significantly higher.
Implementing requirements as a system of market auctions rather than quotas, as Maisel
proposed, would allow more flexibility. Institutions would not have to carry the specified
proportion (say, 25 percent) in loans to preferred sectors. Intermediaries that exceed the
limit would obtain a permit that they could then sell to institutions whose loans to
preferred sectors are below the minimum. Individual institutions could therefore choose to
maintain particular market niches. At the same time, the system would ensure that some
niches carried an extra burden of either higher reserves or purchases of “preferred asset
permits.”
A fourth measure that could channel credit to priority areas and reduce risk in U.S.
financial markets would focus and expand the federal government’s already extensive but
unwieldy system of direct lending and loan guarantees. The U.S. government has long
been heavily invested in domestic financial markets as a direct lender and even more
significantly as a loan guarantor. The sectors of the economy receiving substantial support
though these loan programs include housing, education, agricultural and rural
development, and small business. As of 2007, the government operated about 140
separate loan guarantee and direct lending programs. That year, the government’s $250
billion of new guaranteed loans and $42 billion of direct loans together represented about
14 percent of the total borrowing by households and businesses in U.S. financial markets.
Outstanding government loans and loan guarantees were $1.4 trillion, about six percent of
total debt. (These programs are separate from the operations of “Government-Sponsored
Enterprises.” Fannie Mae and Freddie Mac were the largest GSEs until they were
nationalized in September 2008 to stave off financial collapse. Other GSEs include the
Federal Home Loan Banks, the Agricultural Credit Bank and Farm Credit Banks, and the
Federal Agricultural Mortgage Corporation.)
Despite their formidable size, these programs have not been integrated into a broader
policy agenda or tied in any way to the Federal Reserve’s monetary policy and interest
rate management efforts. They operate rather as financing vehicles for distinct programs,
from student loans to rural business development. Their influence on overall financialmarket risk or borrowing costs has not been considered, nor has their effectiveness in
leveraging relatively small amounts of public funds to move private financial markets in
socially desirable directions.
An expanded loan-guarantee program could be included as a tool to promote financial
stability and social welfare. Assume, for example, that the government roughly doubled its
2007 level of loan guarantees. The additional $300 billion per year could be earmarked for
green investments and affordable housing, and we would set an explicit level of guarantee
at, say, 75 percent. The government then would be the guarantor for $225 billion in loans
for green investments and affordable housing. Interest rates on these subsidized loans
would fall with the reduced level of risk—i.e. by 75 percent relative to the difference
between a market interest–rate bond and a risk-free government bond. If the market
interest rate is 10 percent and a government rate 5 percent, the subsidized rate would be
6.25 percent—the 10 percent market rate minus 75 percent of the 5 point difference
between the market rate and the 5 percent risk-free government bond rate.
Under this arrangement, private lenders would still bear significant risks and therefore
have strong incentives to evaluate loan applications carefully. Market forces would be at
work, but the policy would rig market activity toward desirable social outcomes.
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How much would such a program cost? That would depend on the default rate for the
loans. In 2007 the government had to cover about $50 billion on an outstanding portfolio
of guaranteed loans of $1.2 trillion. This is a default rate of 4 percent. At this rate, our
proposed addition of $300 billion in guaranteed loans would cost roughly $9 billion more
per year in loan receivables, increasing the overall federal budget by 0.3 percent. But it
would leverage more than $300 in private loans for every dollar in government spending.
This sort of loan-guarantee program could serve as a carrot to the stick of asset-based
reserve requirements for private financial institutions.
Fifth, and finally, I propose the formation of a public credit-rating agency to compete with
the private agencies such as Moody’s, Standard & Poor’s, and Fitch. These rating
agencies contributed significantly to the housing bubble and subsequent crash of 2007-08
by consistently delivering overly optimistic assessments of risky financial ventures,
especially in securitized asset markets.
Rating agencies are supposed to be in the business of providing financial markets with
objective and accurate appraisals of the risks associated with purchasing a given financial
instrument. In part, they understated risk in recent years because they relied on orthodox
economic theories in their appraisals. But more important for our purposes is that market
incentives themselves pushed the agencies toward providing excessively favorable
appraisals. Giving a favorable risk appraisal was good for the rating agencies’ bottom
lines, and the agencies responded predictably.
In principle, marketplace incentives should push the agencies toward accurate appraisals
because supposedly the only valuable product agencies offer is credibility. One would
expect market competition to reward firms that provide better information. But a large
gap exists between the ideal set of incentives and the real ones. In practice, rating
agencies show strong bias toward favorable ratings for a simple reason: they are hired by
the companies they evaluate. Companies therefore choose agencies that they think are
likely to provide favorable ratings; those ratings, in turn, enhance the companies’ ability to
sell their financial instruments.
With the benefit of hindsight, the agencies’ misjudgments are now widely recognized.
Economics writer Roger Lowenstein recently offered this appraisal in The New York
Times Magazine:
Over the last decade, Moody’s and its two principal competitors, Standard &
Poor’s and Fitch, . . . [put] what amounted to gold seals on mortgage
securities that investors swept up with increasing élan. For the rating
agencies, this business was extremely lucrative. Their profits surged . . . . But
who was evaluating these securities? Who was passing judgment on the
quality of the mortgages, on the equity behind them and on myriad other
investment considerations? Certainly not the investors.
The investors assumed that rating agencies were providing objective and accurate
appraisals. Agency evaluations shape how investors price assets, which in turn has a major
impact on whether and how investment projects get financed.
The outsized importance of securitized assets as a share of overall market activity only
compounded perverse incentives. In financial markets dominated by securitization, the
primary way banks or other financial intermediaries earn money is not holding onto loans
and collecting interest. Rather, banks earn fees by selling individual loans to entities such
as Fannie Mae or Freddie Mac that want to bundle the loans into securities. Fannie and
Freddie will themselves earn another round of fees by selling their bundled loans on the
market. Still more fees can be earned by selling insurance policies on the securitized
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bundle of loans.
What makes securitized assets more valuable in the market than the underlying bundle of
loans is that the risks associated with those loans have been reconfigured, repackaged, and
presumably clarified for market participants. Without a favorable rating, securitized assets
are simply not marketable. With a favorable rating, opportunities to earn fees emerge at
all points in the chain of securitizing, insuring, and trading, with market traders always
keeping their fees, no matter what happens at some later date to the underlying asset.
A public credit-rating agency would counterbalance this perverse incentive system. Its
staff would be compensated as high-level civil servants. They would receive no benefits
from providing either favorable or unfavorable ratings. Indeed, a compensation system
could reflect the accuracy of their risk assessments over time.
It is true that providing accurate risk appraisals has become increasingly challenging as
securitized markets have deepened. The pubic agency’s staff may well conclude at times
that an instrument is too complex to allow for an accurate appraisal. But the agency would
be obligated to be open with such an assessment—that is, to assess an instrument as “not
ratable.” Financial market participants could then decide whether they want to gamble
with such an instrument.
Private agencies could still operate as they wish, but would have to explain any large
divergence from the public agency in their assessments. Public rating would weaken the
biases in favor of greater risk and complexity, and move financial-system operations to a
higher level of transparency. It could even provide the basis for establishing the
asset-based reserve requirements for loans and other assets held by financial institutions.
As risk assessment would likely become more cautious under a public credit-rating
agency, the market’s enthusiasm for financial innovation would likely dampen. Indeed,
this would partly be the point of such a measure. But it need not make the overall
economy less innovative or dynamic. With a public credit-rating agency and the other
measures proposed here, the dynamism of a leashed financial market would emerge in the
way that credit moves into productive areas.
***
At the end of 2008, the financial crisis and recession made respectable a question that
would have been unthinkable only months earlier: whether privately owned financial
institutions—at least the largest and most important institutions that represent the
“commanding heights” of Wall Street—should not merely be re-leashed through
regulation, but substantially nationalized, operating with public ownership. After all, the
federal government under George W. Bush already nationalized Fannie Mae and Freddie
Mac as part of its fall 2008 bailout operations.
The main arguments for nationalization are straightforward. First, the failings of an
unregulated financial system are now blazingly apparent. Re-leashing financial markets in
some form is no longer a matter of dispute; only the question of how best to do it remains.
One path would eliminate private ownership of financial institutions altogether.
Second, even while assuming equity positions in several large financial institutions at the
end of 2008, the government did not insist on exercising significant authority over
management decisions. Nor did it clearly establish a claim on any profits once the crisis
subsides. With banks fully nationalized, the government would be the clear operational
manager of the institutions as well as the claimant on profits.
Third, without nationalization, we can be certain that Wall Street will fight vehemently, as
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it always has, to minimize regulations that might limit its ability to make profits. Such
efforts will include attempting to corrupt the regulators and the elected officials
overseeing them. Most such efforts will be entirely legal: assuming the regulators are
generous toward the industry they are regulating, they will find opportunities for lucrative
employment within the industry once they quit their public-sector jobs and move into
private-sector positions.
These are important considerations, but they do not constitute an adequate case for
nationalization over a new financial regulatory system. We would face significant
problems under nationalization. Unlike France or Japan, the United States does not have a
longstanding tradition of direct public ownership of major financial institutions.
Realistically, we would have every reason to expect a wide range of failures and
misjudgments, including “crony capitalism”—privileged back-room dealings with selected
non-financial firms.
Even putting aside problems of corruption, we need to recognize that individual financial
enterprises, as with all business entities, literally need micro-management. The U.S.
government has at times managed the economy at the macro level reasonably well. But
the challenges for the government to combine the demands of both micro- and
macro-level management would be formidable. The details of day-to-day management
aside, the government would have to create an incentive system for the managers of the
publicly owned banks that would substitute for the profit-maximizing incentives that guide
managers of private banks. If the nationalized banks are not committed to maximizing
profits, how should their performance be evaluated?
Resolving such questions would require years of experimentation and fine-tuning. In the
meantime, U.S. taxpayers would pay for inevitable breakdowns of the nationalized
system. The tolerance for breakdowns would likely be low, and every misstep or
mini-scandal could undermine the legitimacy of the new system. In the end,
nationalization could undermine the larger project of reestablishing a major public-sector
presence in the financial system. Indeed, the failures of the nationalized system could be
the very thing—perhaps the only thing—that could shift the target of public outrage over
the collapse of the financial system off Wall Street and onto the U.S. government.
At this juncture, it seems preferable to promote financial stability and social welfare by
leashing the markets and thereby reorienting their priorities, not by choking them off
altogether.
***
A range of forces in the U.S and global economies have combined to create the most
severe economic crisis since the 1930s. We will debate for years to come how these
forces came together and how they interacted once combined. But one factor stands out
as the greatest cause of the crisis. This is the collapse of the U.S. financial system. The
financial-system collapse can be traced, in turn, to the dismantling since the 1970s of the
Glass-Steagall financial regulatory system. Glass-Steagall was created in the 1930s
precisely to prevent a recurrence of that era’s economic disasters. Both Democratic and
Republican political leaders must now accept responsibility for the current calamity.
We now begin what will necessarily be a long process of building a regulatory system
capable of mobilizing the economy’s financial resources for productive economic activity
instead of casino capitalism. With the collapsed model of the deregulated financial system
now before us, the set of proposals offered here are a starting place for forming a stable
and equitable financial structure for the U. S. economy.
Read other pieces in this special economics feature by Dean Baker
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(http://www.bostonreview.net/BR34.1/baker.php) and Jeff Madrick
(http://www.bostonreview.net/BR34.1/madrick.php) .
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1/23/2009 6:23 PM